Financial Accounting Chpt 1

8/3/2019 Financial Accounting Chpt 1

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The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

FINANCIALACCOUNTING

Robert Libby

Patricia A. LibbyDaniel G. Short


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Chapter 1

Financial Statements and

Business Decisions


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The Objectives of Financial

Accounting

Financial statements are the primarymeans of communicating financialinformation to parties outside the

business organization.Balance Sheet

Income Statement

Stakeholders


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Business Background

Business owners (called investors orstockholders) look for two sources ofpossible gain:

Sellownership

interest in the

future for morethan they

paid.

Receive aportion of thecompanys

earnings in cash(dividends).


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Business Background

Creditors lend money to a company for aspecific length of time and gain bycharging interest on the money loaned.

DanasDiner

Loan

Interest


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Understanding Business

Operations

Manufacturers either make the partsneeded to produce its products or buythe parts from suppliers.

Manufacturer Product Customer


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Operations

All businesses have an accountingsystem that . . .

Collects and processesfinancial information

about an organization.

Reportsinformationto decision

makers.

Businessmanagers(internal)

Investors(external)


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Operations

Accounting System

Financial Accounting System

(preparation of four basicfinancial statements).

Managerial Accounting System

(preparation of detailed plans,forecasts and reports).

External Decision Makers(investors, creditors,

suppliers, customers, etc.).

Internal Decision Makers(managers throughout the

organization).


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Information Conveyed in

Financial Statements

The four basic financial statements . . .

Income StatementBalance Sheet

Statement of Cash Flows Statement of Retained Earnings


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Information Conveyed in

Financial Statements

Most companies prepare financialstatements at the end of the quarter(called quarterly reports) and the end

of the year (called annual reports).2001

X


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Lets look atMAXIDRIVE

CORP.sfinancial

statements.


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MAXIDRIVE CORP.

Balance Sheet

At December 31, 20A(In thousands of dollars)

Assets

Cash 4,895$

Accounts receivable 5,714

Inventories 8,517Plant and equipment 7,154

Land 981

Total assets 27,261$

Liabilities and Stockholders' Equity

Liabilities

Accounts payable 7,156$

Notes payable 9,000

Total liabilities 16,156$

Stockholders' Equity

Contributed capital 2,000$

Retained earnings 9,105

Total stockholders' equity 11,105

Total liabilities and stockholders' equity 27,261$

1. Name of entity(the separate-entity assumption)

2. Title of statement

3. Specific date(financial snapshot at a specificpoint in time)

4. Unit measure

(thousands of dollars)


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The Balance Sheet

Body of the Statement

Assetsq Economic benefits owned by the business as a result of past

transactions.

Liabilitiesq Debts or obligations of the business that result from past

transactions.

Stockholders Equityq Amount of financing provided by owners of the business and

operations.

Body of the Statement

AssetsAssetsq Economic benefits owned by the business as a result of past

transactions.

LiabilitiesLiabilitiesq Debts or obligations of the business that result from past

transactions.

Stockholders EquityStockholders Equityq Amount of financing provided by owners of the business and

operations.


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The Balance Sheet

Basic Accounting Equation

Economic Sources of financing . . .resources Liabilities: from creditors

Equity: from stockholders.

=

Assets = Liabilities + Stockholders EquityAssets = Liabilities + Stockholders Equity


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MAXIDRIVE CORP.

Balance Sheet


Assets

Cash 4,895$



Land 981



Liabilities


Notes payable 9,000







Assets arelisted by their

ease ofconversioninto cash.

Cash Amount of cash in the companys bankaccount.

Accounts

receivable

Amounts owed by customers from prior

sales.

InventoriesPartial and completed but unsold

product.

Plant and

equipmentFactories and production machinery.

Land Property on which factories are located.


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MAXIDRIVE CORP.

Balance Sheet


Assets

Cash 4,895$



Land 981



Liabilities


Notes payable 9,000







Accountspayable Amounts owed to suppliers for priorpurchases.

Notes

payable

Amounts owed on written debt

contracts.


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MAXIDRIVE CORP.

Balance Sheet


Assets

Cash 4,895$



Land 981



Liabilities


Notes payable 9,000







Contributed

capital

Amounts invested in the business by

stockholders.

Retained

earnings

Past earnings not distributed to

stockholders.


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MAXIDRIVE CORP.

Balance Sheet


Assets

Cash 4,895$



Land 981



Liabilities


Notes payable 9,000







Use $ on thefirst item in a

groupand on thegroup total.

Assets = Liabilities + Stockholders Equity


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MAXIDRIVE CORP.

Income Statement

For the Year Ended December 31, 20A

(In thousands of dollars)

RevenuesSales revenue 37,436$

Expenses

Cost of goods sold 26,980$Selling, general and administrative 3,624

Research and development 1,982

Interest expense 450

Total expenses 33,036

Pretax income 4,400$

Income tax expense 1,100

Net income 3,300$

1. Name of entity2. Title of statement

3. Specific date (Unlike the balance sheet, thisstatement covers a specified period of time.)4. Unit measure (in thousands of dollars)


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

The income statement is divided intothree major captions.

!

"

#


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

Revenues are earnings from the sale of goods

or services.

Revenue is recognized in the period in whichgoods and services are sold, not necessarily

the period in which cash is received.


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The Income Statement

June 2001

Cash from salecollected on June 10th.

XMay 2001

$1,000 sale madeon May 25th.

X

!!RevenuesRevenues

When will the revenue from thistransaction be recognized?

Earnings from the sale of goods or services.


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May 2001

$1,000 revenue$1,000 revenue

recognized in Mayrecognized in May

Earnings from the sale of goods or services.

When will the revenue from thistransaction be recognized?

June 2001

!!RevenuesRevenues


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

Expenses are the dollar amount of resources used

up by the entity to earn revenues during a period.

An expense is recognized in the period in which

goods and services are used, not necessarilythe period in which cash is paid.


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

Cost ofgoods sold

The cost of the products sold thisperiod.

Selling,

general andadministrative

Operating expenses not directly related

to production.

Research and

development

Expenses incurred to develop new

products.

Interest

expenseThe cost of using borrowed funds.

Income tax

expense

Income taxes on current periods pretax

income.


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May 2001 June 2001

May 11 paid $75 cashfor newspaper ad.

X

Ad appearson June 8th.

X

"" ExpensesExpensesThe dollar amount of resources used

up by the entity to earn revenuesduring a period.

When will the expense for thistransaction be recognized?


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May 2001 June 2001

Advertising expenseAdvertising expenserecorded in June.recorded in June.

The dollar amount of resources usedup by the entity to earn revenues

during a period.



"" ExpensesExpenses


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

When revenues exceed expenses,we report net income.


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MAXIDRIVE CORP.

Income Statement




Expenses







Net income 3,300$

When expenses exceed revenues,

we report net loss.


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Statement of Retained Earnings

Income of the enterprise.

Stockholders

D

ivide

nds Retained

byenterprise

Retained Earnings


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MAXIDRIVE CORP.




Retained earnings, January 1, 20A 6,805$Net income for 20A 3,300

Dividends for 20A (1,000)

Retained earnings, December 31, 20A 9,105$

1. Name of entity2. Title of statement

3. Specific date (Like the income statement, thisstatement covers a specified period of time.)4. Unit measure (in thousands of dollars)


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MAXIDRIVE CORP.




Retained earnings, January 1, 20A 6,805$Net income for 20A 3,300

Dividends for 20A (1,000)

Retained earnings, December 31, 20A 9,105$


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NotesNotes provide supplemental

information about the financialcondition of a company.

Three types . . .

Describe accounting rules applied.Present additional detail about an

item on the financial statements.

Provide additional informationabout an item not on the financialstatements.


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Decision makers need to understandDecision makers need to understand

accounting measurement rules.accounting measurement rules.

Responsibilities for the Accounting

Communication Process

Effective communication means that

the recipient understands what thesender intends to convey.


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The Securities and Exchange CommissionSecurities and Exchange Commission (SEC)

has been given broad powers to determinemeasurement rules for

financial statements.

Securities Act of 1933Securities and Exchange Act of 1934

Generally Accepted Accounting

Principles (GAAP)


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Principles (GAAP)

Currently, the Financial AccountingFinancial Accounting

Standards Board (FASB)Standards Board (FASB) is recognizedas the body to formulate GAAP.

The SEC has worked closely with the

accounting profession towork out the detailed rules that have

become known as GAAP.


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Principles (GAAP)Companies are interested in

GAAP because methods ofreporting can have the followingeconomic consequences . . .

! Affect the selling price of stock." Affect the amount of bonuses received

by managers and other employees.# Cause a loss of competitive advantage.


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To ensure the accuracy of the companys

records management: Maintains a system of controls.

Hires an outside independent auditor.

Board of directors review these two safeguards.

Management Responsibility and

the Demand for Auditing


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Independent Auditors

$Auditors express an

opinion as to thefairness of the financialstatement

presentation.$ Independent auditors

have responsibilities

that extend to thegeneral public.

Overall, I believe

these financialstatements arefair.


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Independent AuditorsAn audit involves . . .

$Examining the financialreports to ensure compliancewith GAAP.

$Examining the underlyingtransactions incorporated intothe financial statements.

$Expressing an opinion as tothe fairness of presentation offinancial information.

E hi R i d


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Ethics, Reputation, and

Legal Liability

The American Institute of Certified

Public Accountants requires that allmembers adhere to a professional

code of ethics.

E hi R i d


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A CPAs reputation for honesty andcompetence is his/her most important asset.

Like physicians, CPAs haveLike physicians, CPAs have

liability for malpractice.liability for malpractice.

Ethics, Reputation, and

Legal Liability


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End of Chapter 1

Documents

Financial Accounting Chpt 1